pension essay questions and answers

7/30/2019 Pension Essay Questions and Answers

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Pension Essay Questions and answers:

(ignore the question #s)

Questions asked most frequently in past exams:

1)Theoretically justify why actuarial g and l seldom create large adjustments to pension expense. How

would you advise the funding manager of a defined benefit pension plan to tret these gains in his

decision on how much to fund to a plan?

We expect them to even out in the long run and if we are going radical in one direction they

should be smoothed out of working years to match benefits with epenses. They however affect

funding decision immmediatly as loss can cause cash shorteges and vice versa. So funding

manager must realize that long term trends may reverse but must react to shortages quicker

than accountants.

2) explain why a defined benefit pension plan may have a greater positive effect on loyalty of employees

than a defined contribution plan. Indicate the administrative and tax differences that may affect a

companys decision as to which to adopt in a business?

4) what is the primary theoretical issue in determining pension expense? Theoretically justify and

indicate how the treatment of actuarial gains and losses reflects that principle?

It is matching pension expense to benefits received since benefits coming from employees

(loyalty, focus contentment) are smooth over time expenses should be smoothed over time.

Actuarial gains and losses are expected to counteract one another over time so we do not over

react in three ways:1) wait till next year to consider gand and loss 2) only gain and loss outside

acceptable range or corridor 3) amortize the excess over time

6) Explain whether actual or expected return on assets are used to determine pension expenses and

why this is so. Which # is used to determine the liability requirement and why is this so?

Expected return is used to help create a smoothing pattern to pension expense which reflects

the smooth benefit pattern received from employees and satisfies the matching principle. In

Liability requirements the fair value of the plan assets is used to determine liability and the plan

asset values reflect actual return on assets. This is because only actual assets could be sold to

pay off pension benefits therefore they should be used t o measure remaining liabilities to be

presented on the balance sheet, the reality is needed on balance sheet.

7) Explain how a large unfunded amendment to a pension plan can affect the liabilities reported under a

pension plan if it is announced on 12/31 of a year. Briefly explain why this unfunded amendment

doesnt affect the pension expense of that year in the same way.

An unfunded amendement will increase the pbo immediately and therefore increase liabilities

on the 12/31 balance sheet. Expenses will not be affected until the following year because


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benefits of the amendment are not obtained until then and matching demands that expense

occur when benefits do.

10) A) actuarial gains and losses get unique treatment on financial statements. Justify the treatment

theoretically and how might this deceive a reader of an income statement. B) How might the balance

sheet help the reader understand the situation surrounding large actuarial losses? How about gains? C)Explain how the footnotes of the financial statements might help the reader understand the situation

regarding large actuarial losses? How about gains?

A) the unique treatment is to spread them out or ignore them unless substantial because they

will tend to cancel out in the long run, employee benefits do not reflect the actuarial gains and

losses, matching the cost to benefit crucial

B) Because the actuarial gain and loss imact the ABO and the ABO is a key factor in determining

B/s results if they are necessary -> large actuarial losses may be required to be shown on B/S.

However since we do not let ABO B/S due to gains appear on B/S gains are not shown on B/S.

C) However since the comparison to PBO is made in footnote and gains and losses impact

footnote disclosure they will both be apparent to the reader.

Questions asked less frequently:

3) Indicate and theoretically justify the 3 different viewpoints of the obligations a company has to its

employees who are eligible for a defined benefit pension plan. Indicate what elements drive each

viewpoint and where on the financial statement the viewpoint will appear? (was on prior to 2007 test)

Viewpoint 1) balance of prepaid/ accrued pension cost account. This is result of matching cost to

benefit periods and simply is based on the fact that if you paid more than exp then asset if paid

less than exp then liability.

Viewpoint 2) ABO- FV plan assets at the B/S date this is based on conservatism principle

meaning that if the plan ends tomorrow and we are short funds to pay everyone off we must tell

the reader of the shortage.

Viewpoint 3) PBO- FV PA or funding status this is even more conservative but it show whatfunding goals are for the company based on actuary prediction and represent how close we are

to goal and shows any shortage.

5) explain what alternative methods to straight line amortization exist for amortizing prior service cost in

a defined benefit pension plan and theoretically justify its use. What does the fasb recommend?


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There is a method that is similar to sum of years digits amortization that is recommended by the

fasb it assigns more expense to the earlier periods and assigns cost to all periods that employees

who are awarded prior service credit. This is best because the # of employees that remain with

the company diminishes over time and therefore benefits diminish. The matching principle

demands that costs are ecpensed in accordance with benefits.

8) (question not listed only answer) winter 2012 exam

pension expense doesnt equal contribution because in gaap we must match the expense to the

benefits received since the benefits from employees is smooth over time we must make an

effort to spread these costs out and funding is not always spread out equally each year. It

depends on the availability of cash.

9) How do you check the OCI account is correct?

You check OCI by making sure it equals unrecognized prior service costs which equals

components 4,5,6 and 7 that have not been expensed or recognized.

11)A) Explain the pros and cons of a defined benefit versus a defined contribution pension plan from the

companies viewpoint B) from the employees viewpoint C) suppose the average annual rate of return on

assets is 30%. Explain how this would affect your answer to item a)

A) The companies viewpoint on defined Contribution pros : Know exactlyu what cost will be.

Con has less long term impact on employee. Defined benefit pros: keeps employee focusing on

today, could cost very little if dies early Cons: cost could be overly high if individual lives long or

salaries increase, hard to account for.

B) Employee Pros: assured of same standard of living during retirement Cons: If market triplesyou dont own funds until retire

C) IF huge return company reaps benefit on defined benefit plan thus defined benefit plan may

have been better (less costly) if this huge return continues

12) explain how the accounting treatment of other post retirement benefits satisfies the matching

principle. Give several expamples.

The factors that determine other post retirement expenses are smoothed out to reflect smooth

benefits thus satisfying matching principle. Spread out actuarial gain and losses. Expected return

rather than actual return for # 3, spread out prior service costs, service cost only this years work

13) Theoretically justify the accountants treatment of a large actuarial loss incurred early in a pension

plans life. What basic principle of accounting may be broken by this treatment?

Little to no expense this period, will offset in the future, benefits are smooth from employees,

matching demands expenses be smoothed as well. It violates conservatism and full disclosure. It

is unusual to not recognize losses as soon as possible.


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14) (question missing on test) fall 2007

There is an Other comprehensive Income Account which is located in the stockholders equity

section of the balance sheet and the current years adjustment shows up in the other

comprehensive income statement. Its balance should be equal to unrecognized prior service

cost that still exist in the plan ( components 4, 5 and 6) which have not been recognized to date.

15) Explain why accountants attempt to smooth out pension expense and why this may cause

the need for a second journal entry related to defined benefit pension plans. Give 3 examples of

how accountants execute the smoothing effect and where in a financial statement package (

besides I/S and B/S a reader can learn more about this smoothing effect and how it relates to

the true funding needs of the plan.

The benefits coming from a pension plan are relatively smooth and to match costs with

benefits we must smooth or spread expenses according to benefits. Because we dont

always receive those benefits as expected liability. May be owed sooner or more than

predicted. A second calculation surrounding potential additional liability problems is

necessary to satisfy B/S needs for conservatism 3 examples of smoothing are: 1)

discount rate rarely changes 2) use expected rate of return 3) amortize PSC using S/L 4)

amortize actuarial G/L using S/L 5) only amortize actuarial G/L in excess of corridor 6)

take S/C at 1/30 of total costs

16) Explain what the funding status of a companys pension plan is useful for and indicate where it may

be found in a financial statement package. Does this amount impact the liability balance of the

company? Why or why not?

Funding status is the relationship between the PBO, the long term goal set by the actuary forassets necessary to pay for the plan and the actual asset set aside in the plan. It is helpful for the

treasurer or finance people in a company to help them make funding decisions to the plan. It is

found in the footnotes not on the B/S or I/S.

Accountants do not consider it part of their liabilities because this amount includes future salary

levels of employer which have notbeen obtained they are technically not a liability at this date

since the employee has not attained that salary level.

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